Chapter 8 Flashcards
Assumptions of the Heckcher-Ohlin Theory
- Two-nations, two commodities, and two factors of production
- Both nations use the same technology in production
- Commodity X is labor intensive and commodity Y is capital intensive
- Both commodities are produced under constant returns to scale in both nations
- There is incomplete specialization in production in both nations. Even with free trade both nations continue to produce both commodities
- Tastes are equal in both nations.(The shape and location of Indifference curves are identical in both nations)
- There is perfect competition in both commodities and factor markets in both Nations
- There is perfect mobility of factors within each nation but no international factor mobility.
- There are no transportation costs, tarrifs, or other barriers to free international trade.
- All resources are fully employed in both nations.There are no unemployed resources or factors of production in either nation.
- International trade between the two nation is balanced.The total value of each nation’s exports equals the total value of the nation’s imports
The assumption of perfect competition in Heckscher-Ohlin Theory means.
- Two nations are too small to affect the price
- In long-run p=cost no economic profit
- Perfect Knowledge
Commodity Y is capital intensive if.
Capital-labor ratio (K/L) used in the production of Y is greater than (K/L) used in the production of X.
To measure the capital and labor intensity of the two commodities, it shouldn’t be measured in absolute terms but by
the amount (ratio) of capital per unit of labor
(i.e., K/L)
Two ways to define factor abundance
- In terms of physical units
- Relative factor prices
Nation 2 is capital abundant in terms of physical units if
The ratio of the total amount of capital to the total amount of labor (TK/TL) available in Nation 2 is greater than that in Nation 1
Nation 2 can have less capital than Nation 1 and still be the capital abundant nation if
TK/TL in Nation 2 exceeds TK/TL in Nation 1
Nation 2 is capital abundant in terms of relative factor prices if
the ratio of the rental price of capital to the price of labor (Pk/Pl) is lower in Nation 2 than in Nation 1
i.e., if Pk/Pl in Nation 2 is smaller than Pk/Pl in Nation 1
Rental price of capital is usually taken to be
the interest rate (r)
price of labor time is
the wage rate (w)
Pk/PL can be written as
r/w
It is not the absolute level of r that determines whether or not a nation is the K-abundant nation, but
r/w
The definition of factor abundance in terms of physical units considers only
the supply of factors
The definition of factor abundance in terms of physical units and in terms of factor prices may not give the same conclusion if
Demand is significantly different between the two countries
If demand is significantly different between the two countries then which definition should be used
relative factor prices
The two definitions of factor abundance give the same conclusions if
we have assumed that tastes, or demand preferences are the same in both nations
If Nation 2 is K-abundant nation and commodity Y is the K-intensive commodity, then Nation 2 can
Produce relatively more of commodity Y than Nation 1.
If Nation 1 is the L-abundant nation and commodity X is the L-intensive commodity, then Nation 1 can
produce relatively more of commodity X than Nation 2
Production possibility frontier for nation 1 ____________ than the production frontier of Nation 2
(if we measure X along the horizontal axis)
Knowing that Nation 1 is L-abundant
is relatively flatter and
wider
The Heckscher-Ohlin (H-O) theory can be presented in two theorems
1.The H-O theorem (which deals with and predicts the pattern of trade)
2. The factor-price equalization theorem (Paul Samuelson) (which deals with the effect of
international trade on factor prices)
The H-O theorem:
Pattern of trade:
A nation will export the commodity whose production requires the intensive use of the nation’s relatively abundant and cheap factor and import the commodity whose production requires the intensive use of the nation’s relatively scarce and expensive factor
According to H-O theorm, The relatively labor-rich nation exports
The relatively labor-intensive commodity
According to H-O theorm, The relatively labor-rich nation imports
The relatively capital-intensive
commodity.
Which theorm explains comparative advantage rather than assuming it
The H-O theorm
The H-O model is often referred to as the
Factor proportions or factor endowment theory.
What is the basic cause of comparative advantage and international trade according to H-O theorm
Relative factor abundance, or factor endowments
According to the H-O theorem, what is the cause of pre-trade difference in relative commodity prices between two nations
The difference in relative
factor abundance and prices
According to the Heckscher-Ohlin model Indifference curve I is common to both nations because
of the assumption of equal tastes
The tangency of Indifference curve I to the production frontier of Nation 1 at point A define
The no trade equilibrium-relative commodity price of PA in Nation 1
The tangency of Indifference curve I to the production frontier of Nation 2 at point A’ define
The no trade equilibrium-relative commodity price of PA’ in Nation 2
Nation 1 has a comparative advantage in commodity X and Nation 2 in commodity Y if
PA and PA’ are the equilbrim price of nation 1 and 2 respectively
PA < PA’
According to H-O theorm, With trade Nation 1 produces at point B, but where is point B?
Further right on Nation’s 1 PPF
Indicating that it increases the production of X
PA and PA’ are
Tangent lines to the PPF at equilibrium point that determine the slope
Nation 1 can reach point E by
producing at point B and by
exchanging X for Y
According to H-O theorm, With trade Nation 2 produces at point B’, but where is point B’?
Further to the left on the Nation’s 2 PPF
Indicates that nation 2 increased the production of Y
Nation 2 can reach point E by
producing at point B’ and by exchanging Y for X
According to heckscher-ohlin model, Both nations gain from trade because
they consume on
higher indifference curve II
